Tobias Salinger
5 min read
Within the sales pitch for interval funds that open access to alternative assets like private credit, there are "fees that are easy to miss and hard to understand," according to Morningstar.
The expense structure for interval funds — the name refers to the set periods when issuers offer to repurchase a percentage of the assets — can "encourage interval fund managers to take additional risks that disproportionately benefit them rather than investors," research firm Morningstar found in a report last month. Fees tied to leverage margins and so-called "hurdles" based on the level of yield may, in certain cases, ratchet up the cost of interval funds to an adjusted, all-inclusive ratio of 3.39% shaved off the top of a 10% gain.
Issuers are marketing the products to financial advisors and their clients as a means of tapping into the private credit boom or getting exposure to other alternative investments. The study shows the possibility for "scenarios in which more than investors will realize will be gobbled up by fees," said Alec Lucas, a co-author of the report who is the director of manager research in the active funds research unit of Morningstar. That is not to say "that all of them are bad options or can't play a useful role in a portfolio," but the results should serve as a reminder to advisors and clients "to exercise some caution in what they're getting for what they pay," he added.
High potential yields from private credit instruments that aren't always available to the mass market are drawing some investors to interval funds, according to Will Gholston, a chartered financial analyst and certified financial planner who is the vice president of investments with New York-based registered investment advisory firm Re-Envision Wealth. However, their high costs are "definitely a significant detractor from the appeal of that structure," requiring careful due diligence of marketing efforts portraying interval funds as offering "attractive yields without outsize risk," Gholston said. Those drawbacks and the lower liquidity than ETFs or other open-end funds explain why he has rarely recommended them to clients.
"More and more you're starting to see various strategies being offered in more of an ETF wrapper, and private credit is getting there," Gholston said. "You definitely have to analyze the full landscape of potential investments to make sure you can't get that exposure for cheaper."
